Muddled Mitt from MA: Trying to Make Sense Out Of Gov Romney’s Tax Plan

October 9th, 2012 at 5:56 am

I watched the debate the other night with a bunch of students and other seemingly normal people far outside of the DC beltway. After the debates were over, we talked about what we’d just heard and everyone was totally confused about Gov Romney’s tax plan. They just didn’t get how he’s going to a) lower tax rates by 20% for everyone, repealing the estate tax and the Alternative Minimum Tax while b) not losing any revenue to the system, and c) not raising taxes on households below $200,000.

Not unlike the President, they seemed deeply confused by the fact that he’s been running on a big tax cut but now seemed to saying…”not so much.”

The fact that you find this confusing is actually a good sign. There’s solid math that says he can’t accomplish all three—more of that in a moment. But here’s a revealing quote from Gov R in last week’s debate:

“I will not reduce the taxes paid by high-income Americans.”

The group found this especially confusing. When is a tax cut not a tax cut?

First, you have to understand that Mitt Romney makes a very big distinction between your tax rates and your tax liability. And in a system like ours with lots of tax deductions and credits, there’s often a difference between the two, especially if you itemize on your return. That’s why people with high incomes—people you’d expect to pay a lot more in taxes because their tax rates are the highest—often face tax bills that are a much smaller share of their income than you’d expect. It’s because of the deductions and favorable treatment of various types of income, like capital gains and dividends.

So, one reason why Romney was so confusing in the first debate—aside from the fact that he made a bunch of stuff up—was that most people think about their taxes in terms of their tax liability, i.e., the check they have to write to Uncle Sam come tax day. But that’s not how he thinks about it. He’s deeply bought into the notion that what really matters to people are their rates, not their liabilities. So, in his world, he can make you better off by lowering your rate, even if he then takes back what he just gave you by closing a loophole from which you benefit.

But besides being disconnected from most people’s experience, this is also where his numbers problem comes in. His plan really does cost $5 trillion over ten years and it’s just deeply misleading when he says it doesn’t. If you take the numbers from the Tax Policy Center and the Treasury (for the elimination of the estate tax), the 10 year costs break down like this:

Lower tax rates by 20 percent = $2.5 trillion

Eliminating the Alternative Minimum Tax = $700 billion

Repeal of high-income payroll tax = $300 billion

Repeal the estate tax = $150 billion

Tax cut for corporations = $1.1 trillion

The interest costs get you to $5t.

Of course, Gov R claims he can offset that cost with base broadening: ending tax deductions, closing loopholes, getting rid of preferences that high-income taxpayers currently tap to great effect to lower their tax bills.

But my liquidity analysis shown here still holds. Families with incomes over $200,000 receive $2.7 trillion of the various breaks noted above and only $1.7 trillion in tax benefits (not counting special treatment for investment income, which Romney has promised not to touch). That $1 trillion difference has to come from somewhere or the revenue neutrality is lost, but since “somewhere” has to by definition include the “middle class” (households earning less the $200,000), that violates a different part of his pledge.

Regardless of his claims in the debate, Romney can’t square this circle. Instead, what I fear will happen if he gets a chance to implement this idea in the current anti-tax climate is the classic tax reform trap I’ve written about many times. You promise lower rates paid for by a broader base, but what you end up with is just the lower rates, not the broader base. It’s a recipe for larger deficits and great after-tax inequality.

Finally, and this is very important, do we really need more large, permanent tax cuts? Romney’s essentially talking about another GW Bush-sized tax cut on top of making the Bush one permanent. Why would anyone other than a devout supply-sider impervious to the evidence of the Bush years want to go there, unless, like those with incomes above $3 million a year, they’re slated for an average tax break of $250,000?

And according to Gov R, even they should think twice, because they’re not getting a tax cut, as in the quote above from the debate. I suspect any of them who were listening didn’t believe him on that point, and I’m afraid they were right not to.

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17 comments in reply to "Muddled Mitt from MA: Trying to Make Sense Out Of Gov Romney’s Tax Plan"

As much as I deplore Mr. Romney’s dishonesty about his tax plan, he did make one suggestion that I think is worth considering.

Politically, the problem with eliminating deductions is that every one has a constituency that will fight tooth and nail to keep it. Romney suggested a way out of this: put a cap on the total amount that any one household can deduct.

Personally, if such a thing were ever passed, I would use the revenue to expand infrastructure and safety net programs, rather than to fund tax cuts. And maybe the reality would be that EVERY constituency would fight the cap, so that it didn’t really help the politics.

But I do think that we need to be creative about how one could start to get us out of this mess of huge numbers of tax preferences that collectively make the tax code so complicated. A cap would, in the long term, make the desire to continually add deductions and loopholes far less. Maybe there is some better way, but I think it is an important goal.

Step 2 – Deduct medical expenses above 7.5% of AGI, state and local income taxes, property taxes, mortgage interest, investment interest, charitable contributions, and work and investment related expenses above 2% of AGI, and personal exemptions ($3700 for yourself and each dependent). These are the majority of deductions that individuals claim. This arrives at taxable income.

Step 3 – Calculate the tax on taxable income.

So the plan is to eliminate deductions in order to increase taxable income. The lower rates applied to the revised taxable income is supposed to generate the same amount of tax revenue. There is really not a whole lot there. And try to get this by the real estate and charitable lobbies.

I think you’re right in the distinction between liability and rates. This should be real simple. Months ago I wanted someone on TV to just mention “effective tax rate,” which I and almost everyone else believe clearly makes this distinction. Finally it’s out there with Romney’s taxes, let’s hope people pick up on it.

Also, it’s funny that cutting deductions and loopholes isn’t introducing “job-killing uncertainty” into the market because it’s being proposed by a Republican.

I had always thought that when Romney said the wealthy would keep paying the “same share of the tax burden they’re paying now,” that this was code for meaning that they would pay the same FRACTION of total tax revenue that they now pay (which means their taxes would decrease, since total revenue would decrease). Others (including, apparently, Mitt Romney at the debate) seem to interpret this as not reducing the taxes paid (by the wealthy). Unclear indeed!

Yes, I’ve heard him say “revenue neutral,” too, but nowhere on his website does this term appear (at least not that I can see). Is this actually “officially” part of his tax plan, or just another talking point so he can sound like moderate Mitt?

The problem with the “deduction cap” idea is that deductions are already effectively capped through the AMT, and through the limit on mortgage deductions.

So, a cap that is coupled with a rate reduction will once again disproportionately benefit the very high earners — the top 0.3% or so. I haven’t seen this discussed much, although David Frum brought it up yesterday.

Thanks for that reminder. Essentially, then, the Romney plan reinstates the AMT with a different wrapper. That would have the benefit of making me swear less at Turbotax when it comes time to doing my taxes ;-). But I think the outcome is the same. The higher your income, the less impact the deductions have on your overall tax burden. So capping the deductions doesn’t matter much. Where it will matter is with people who are high earners, but not “very high” — in the $200K to $500K range or so. They, on average, are likely to have relatively high mortgage deductions, property tax and state income tax deductions — especially in CA, NY, MA.

Lower tax rates will disproportionately benefit the very high earners.

I understand how tax deductions and credits distort the economy, but keeping taxes paid constant by lowering rates and eliminating deductions and credits will have a profound effect on domestic spending. Consider that I have to spend $2857 in mortgage interest to receive $1000 in tax deduction. Even the tax credits are often a percentage of the amount spent like the recent energy efficient HVAC credits. Allowing me to pay the same in taxes without having to pay mortgage interest or property taxes or buy a new HVAC system changes the calculations on my discretionary spending. But do I hire a landscaping crew or take my wife to Ireland on British Air? Only one of those contributes to the US economy.

Those “loopholes” are primarily there to encourage investment or behavior conducive to a better functioning society like charitable contributions. Let’s not just assume that lower rates and closing loopholes will improve investment and economic growth. We did that in 1986 and have had one financial bubble and collapse after another ever since.

What does he mean by “base broadening”. I wish someone would explore that – it seems like another piece of jargon thrown out there to obscure what he wants to do. To me, “base broadening” means that the base (i.e. low income voters who pay very little or no taxes) will have have more of their income taxed to make up for the reduction in taxes collected from those at the top. So a tax cut for the wealthy will be balanced on the backs of the poor “lucky duckies” who are least able to afford it.

Another issue – if the plan is revenue neutral (i.e. everyone still roughly pays the same), then what is the point? Why scrap what we have now and are already familiar with for such a big unknown? If everyone’s net after tax income hasn’t changed, then why bother going through all that change? As Ryan above commented, won’t this introduce one helluva lotta “job killing uncertainty” into the mix?. I believe Romney knows this translates into a huge tax cut for the wealthy and is trying to slip one by us.

I’m in favor of incremental change. Scrap the AMT and eliminate deductions in order to pay for it.

I fear you’re not reading Romney’s statement sufficiently carefully. He doesn’t mean that his proposed base broadeners will increase upper income tax liabilities by enough to maintain the existing effective tax rate on these taxpayers (they won’t). He means that he’s planning to use dynamic scoring to assume a sufficiently big increase in the upper income tax base beyond the statutory base broadening so that there is no cut in the amount of tax paid by the upper income taxpayers, despite the reduction in their nominal and effective tax rates.

Of course, Gov R claims he can offset that cost with base broadening: ending tax deductions, closing loopholes, getting rid of preferences that high-income taxpayers currently tap to great effect to lower their tax bills.

In theory, this might work. In reality, it won’t and can’t for political reasons. The money is in the large loopholes/exemptions that go to middle/upper class: Mortgage interest, employer health insurance, charitable deductions,etc.,all of which are politically untouchable.

It isn’t just his conflation of tax rates and liability. In the debate he made a statement about how if he doesn’t like his insurance plan he would just change it. But the majority, if not the vast majority receive their insurance from their employer – we can’t just change plans with changing employers.

Someone who has lived their whole life very wealthy cannot understand what it is to work for a living. Yes, Ann Romney worked in the home – that’s a job but she never had to worry about a lay off or the plant closing.

Mr. Bernstein, You don’t site a source for your 1.7T figure. I saw in the AZ Republic an article probably attributed to the AP which I remember cited the TPC
saying that if all of the possible credits and deductions(which the reduction of balance the revenue loss from rate cuts per MR) that those above 200K currently receive were wiped out it would not produce enough revenue to counter balance the income saved from the rate cut side of MR’s plan for those same folks. Thus that class receives a net tax cut which means those below the 200K level would have to make up the difference with higher net taxes in order to maintain revenue neutrality. And I think the point was that there is enough value in cred/ded’s for the sub200k group to over compensate for their reduced rates in the plan with cuts to their tax preferences, and end up with enough revenue to make the whole package revenue neutral. There was a posting of how much the 200K+ group net saved and how much more the average sub200K household would pay. Bottomline: Rich pay less, middle income pay more. Went to the TPC site and couldn’t find article. Help me?

From the comments it is clear that Romney is not qualified to be President. An essential qualification is telling voters CLEARLY what you plan to do to them before they are asked to vote for you. With a different interpretation by almost every commenter above, Romney has yet to pass that fundamental test.

And no, it is not sufficient to say that we’ll learn the details after the election, or that we’ll then have time to “debate” the issues, or that nothing Romney says can happen without such debate because Congress would need to act. Unlike Obama, who can’t get anything done without a Republican house approval, Romney, if he wins, will very likely be able to pass anything he wants.

Finally, for those here who think he is really just a moderate in tea party clothes, you will be sadly mistaken. He is out to eliminate the estate tax for people in his class — a $100 billion benefit to his family alone. And his constituency, i.e., all those individuals in the FIRE economy who first captured our regulatory system and then used the Federal Reserve, the tax code and boomer demographics to amass hundreds of billions of dollars of Ponzi “wealth” — fortunes that will ensure their families become permanent oligarchs — will do everything in their power to make this a permanent tax cut to protect those fortunes. It will not be revenue neutral. It will not require the rich to pay the same taxes. It will shift taxes to the 99%, (including the 47%). At the same time, he will borrow the shortfall and give our children the bill, with interest payable to his family because they and other wealthy Americans will own the treasury bonds our government will be forced to issue.